The government was last night facing the very real prospect of the first British consumers losing substantial amounts of their savings following the collapse of the popular internet bank Icesave.

More than 300,000 British savers had accounts worth in total £4bn with the Icelandic bank, attracted by best-buy savings rates of more than 7%, on offer as recently as Monday.

But yesterday withdrawals were frozen after its parent group, Landsbanki, went into receivership. Savers desperate to withdraw their cash found they were unable to log on to the website, and, unlike savers with Northern Rock, now face losing any balances above the government's protection limit of £50,000. They can also expect a wait of at least three months before they are reunited with their cash.

Heritable Bank, another British-based subsidiary of Landsbanki which holds savings of £900m, also shut its doors to withdrawals.

The turmoil at Landsbanki also cast a pall over West Ham United, already reeling from the loss of its shirt sponsor last month. Landsbanki's chairman and major shareholder, billionaire Bjorgolfur Gudmundsson, bought the club in 2006. Yesterday West Ham said the club was not for sale and that the owner remained "as committed as ever".

Savers swamped internet discussion groups as it became apparent that they will have to rely on the Icelandic Compensation Scheme for the first €20,887 (£16,264) if Landsbanki is officially declared in default.

Most had assumed that as Icesave was authorised by the Financial Services Authority, it qualified for the full £50,000 protection under the Financial Services Compensation Scheme. But there was shock and anger as savers learnt that Icesave (although not Heritable) operated under little-known "top-up" rules in which the bank's host country pays the first segment of compensation.

Many worry that Iceland, whose entire economic output is £8bn a year, will be unable to fund its compensation scheme. Landsbanki is the second of the country's big three banks to fall victim to the credit crunch, and fears are growing of a financial meltdown in the tiny nation, whose population of 305,000 is little more than Brighton & Hove. A £4bn-plus bill to compensate UK account holders at Icesave would far exceed its foreign reserves.

But yesterday Iceland's prime minister, Geir Haarde, pledged to borrow funds if necessary to keep the compensation scheme afloat, and said he was in negotiations with Russia for a $4bn lifeline for the country's ailing economy.

In Britain, the FSCS said it is under no obligation to fund compensation if a local scheme is declared in default. As of yesterday, Landsbanki had not been declared officially in default, but the FSCS said such a move was now expected. FSCS Chief executive Loretta Minghella added: "We are pulling out all the stops to help those who have deposits with Icesave. We know they will be feeling anxious today and want to reassure them we will do everything we can to help them get the help they are entitled to as quickly as possible."

A Treasury official said last night: "The UK authorities have been working with their Icelandic counterparts to make sure that UK savers receive the money to which they are entitled." There were no pledges of protection above £50,000, although officials are understood to be trying to find ways to ensure no savers lose out.

Financial expert Martin Lewis called on the UK government to clarify its position. "It's unfairly leaving people panicked and worried - the UK should be prepared to step in if necessary. So far the Treasury isn't saying whether it will pay that money if Iceland can't."

Liberal Democrat Treasury spokesman Vince Cable criticised cross-border regulatory systems which allowed Icesave to be relatively lightly regulated in the UK. "It is clear that Icelandic regulators have not done a very good job," he said. "The pressure on the UK government to pay out to Icesave savers will now be intense."

Ernst & Young were yesterday appointed as administrators for Heritable in the UK. An E&Y spokeswoman said: "As I understand it, all retail savers' deposits at Heritable are safe, even above the £50,000 level. We will be issuing a full statement when matters become clearer."

In Iceland, the government used sweeping powers over the country's banks granted in the Reykjavik parliament on Monday night. The board of directors at Landsbanki were dismissed and the bank put into receivership yesterday morning.

The government also loaned €500m to Kaupthing, Iceland's biggest bank, which has a UK savings arm called Kaupthing Edge. Yesterday it was battling to halt a run on its UK accounts, telling investors that, unlike Landsbanki, it is covered in full by the FSCS.

The fate of Iceland's economy is seen as a warning for the rest of the world, after a long boom fuelled by debt, a dependence on its banking industry, and a buoyant housing market.